Monday, August 24, 2015

Nary a pullback goes by without at least a handful of requests to update my pullback table to help put the current pullback in perspective. Whether the current market action is best described as a pullback, correction or even bear market, I am happy to oblige.

For those who may new to this graphic, note that the table below includes only S&P 500 Index pullbacks from all-time highs and only those that go back to the March 2009 bottom. (Due to the all-time high requirement, I count back to the May 20th intraday high of 2134.72, even though almost all of the damage has been done in the past three days.) In terms of defining the minimum pullback for the table, here 2.75% seems to be a natural cutoff, but I am more apt to include smaller numbers if it took a relatively large number of days to arrive at the bottom. Of course the current move does more than just squeak in: it is now the third largest in terms of magnitude at 12.5% and second longest from peak to trough, at 66 days.

Worth noting is that the #1 pullback (21.6% in 2011) saw a peak VIX of 48.00 during the decline, while the #2 pullback (17.1% in 2010) coincided with a maximum VIX of 48.20. The current pullback falls into the #3 slot, while the #4 pullback (10.9% in 2012) saw a maximum VIX of only 26.71. For the record, today’s VIX intraday high of 53.29 is the highest VIX on record outside of the 2008-2009 financial crisis, with data going back to 1990.

[source(s): CBOE, Yahoo, VIX and More]

While there is no obvious proximate cause of the current pullback and VIX spike, it is clear that concerns about slowing growth in China is the main source of investor anxiety. Investors are clearly uneasy about various sub-plots related to the real level of China’s GDP, the impact of slowing Chinese growth on commodities and related markets, speculative excess and bubbles in China’s domestic stock market (ASHR) and real estate market (TAO) or broader concerns about the ability of the Chinese government to manage the economic transition from infrastructure-driven growth to growth based on domestic consumption.

Sharp selling and higher volatility has been present for many months in commodities and currencies. Only recently has the selling and higher volatility spilled over into Chinese equities and emerging markets as a whole. In fact, emerging markets have suffered greatly as of late, with the popular EEM ETF plummeting during the last two weeks and now down 32% from its April high. At the same time, the VXEEM emerging markets volatility index soared to record of 111.39 on an intraday basis today, crushing the previous all-time high of 86.44.

As with all big pullbacks, at this point we only know that we are closer to a bottom and have no assurance that the current bottom will hold. Most likely it will be tested again in the next day or two and traders will take their cues based on how well SPX 1867 holds up as support. Related posts:

Many readers have commented that one of their favorite of my regular graphics is the table of VIX spikes of 30% or more that I update periodically in this space, along with the subsequent performance in the S&P 500 Index following these spikes.

This time around I have elected to add an additional column that identifies the catalysts involved (necessarily a subjective process) in each instance. When thinking about these catalysts, it might be helpful to compare the nature of the threat and the size of the VIX spike to changes in volatility during various high-profile historical events, an analysis I captured in Volatility During Crises. Another useful exercise is to think about the fundamental factors influencing each VIX spike in the context of A Conceptual Framework for Volatility Events, which I find particularly useful in helping to gauge just how large of a VIX spike a certain type of event might trigger.

Of course the table below has its own set of data nuggets, both fundamental and technical. One interesting statistic I find worth highlighting is the relatively high frequency of large VIX spikes that have occurred during the past five years. VIX data goes back 26 years and yet more than half of the VIX spikes in this table data are from the past five years. I think it is no coincidence that the VIX ETPs (initially VXX and VXZ) were launched in 2009 and the inverse VIX ETPs (XIV and ZIV) and leveraged VIX ETPs (starting with TVIX) were launched in the following year, when big VIX spikes suddenly became more common – much more so than during the 2008 financial crisis, the dotcom crash, etc. For additional information on the subject of more VIX spikes in spite of a generally lower volatility environment, check out 2014 Had Third Highest Number of 20% VIX Spikes.

[source(s): CBOE, VIX and More]

As noted previously, based on the data for all VIX spikes in excess of 30%, the SPX has a tendency to outperform its long-term average over the course of the 1, 3 and 5-day periods following the VIX spike. Also worth noting that that 10 and 20 days following the VIX spike, the SPX has a tendency not only to underperform, but to decline. Further, while the huge decline following 9/29/08 VIX spike tends to dwarf the other data points, even when you remove the 9/29/08 VIX spike it turns out that the SPX still loses money in the 10 and 20-day period following a VIX spike. When the analysis is extended out 50 trading days, the SPX is back to being profitable, but performing below its long-term average. On the other hand, when the analysis includes 100 days following the VIX spike, the SPX is back to outperforming its long-term average.

In summary, this data suggests that following a 30% one-day VIX spike, there appears to generally be a tradable oversold condition in stocks that lasts approximately one week, followed by a period of another month or so in which the markets typically has difficulty coming to terms with the threat to stocks. This tendency makes today’s market action even more remarkable in that today was by far the worst performance of the SPX in a day following a 30% VIX spike.

Taking a longer-term perspective, looking out at least one quarter, all fears are usually in the rear view mirror and stocks are likely to have tacked on significant gains.

As noted many times here in the past, the data in this table supports the idea of both short-term and longer-term mean reversion, but calls into question the role of mean reversion in the 10-20 days following a VIX spike, where fundamental factors have a tendency to overwhelm a technically oversold condition in stocks.

Purpose of this Blog

The intent of this blog is to educate, inform and entertain readers, while also serving as an archived learning laboratory of sorts as I try to sharpen my thinking in areas such as volatility, market sentiment, and technical analysis. I also enjoy charging off on tangents and hope that readers may find some illumination or at least amusement in these forays.

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About Me

Chief Investment Officer at Luby Asset Management LLC in Tiburon, California. Previously worked as a full-time trader/investor and also a business strategy consultant. Education includes a BA from Stanford and an MBA from Carnegie Mellon.
Useless trivia: I once broke the world pogo stick jumping record without knowing it.